The Fabric of Economic Trust
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Economics acquired its dismal reputation by pretending to be an
exact science rather than a branch of mass psychology. In truth it is a
narrative struggling to describe the aggregate behavior of humans. It seeks to
cloak its uncertainties and shifting
fashions with mathematical formulae and elaborate econometric computerized
models.
So much is certain, though - that people operate within markets,
free or regulated, patchy or organized. They attach
numerical (and emotional) values to their inputs (work,
capital) and to their possessions (assets, natural endowments). They communicate
these values to each other by sending out signals known as prices.
Yet, this entire edifice - the market and its price mechanism
- critically depends on trust. If people do not trust each other, or the
economic "envelope" within which they interact - economic activity gradually
grinds to a halt. There is a strong correlation between the general level of
trust and the extent and intensity of economic activity. Francis Fukuyama, the
political scientist, distinguishes between high-trust and prosperous societies
and low-trust and, therefore, impoverished collectives. Trust underlies economic
success, he argued in a 1995 tome.
Trust is not a monolithic quantity. There are a few categories of
economic trust. Some forms of trust are akin to a public good and are closely
related to governmental action or inaction, the reputation of the state and its
institutions, and its pronounced agenda. Other types of trust are the outcomes
of kinship, ethnic origin, personal standing and goodwill, corporate brands and
other data generated by individuals, households, and firms.
I. Trust in the playing field
To transact, people have to maintain faith in a relevant
economic horizon and
in the immutability of the economic playing field or "envelope". Put
less obscurely, a few hidden assumptions underlie the continued economic
activity of market players.
They assume, for instance, that the market will
continue to exist for the foreseeable future in its current form. That
it will remain inert - unhindered by
externalities like government intervention, geopolitical upheavals, crises,
abrupt changes in accounting policies and tax laws, hyperinflation,
institutional and structural reform and other market-deflecting events and
processes.
They further assume that their price signals will not be
distorted or thwarted on a consistent basis thus skewing the efficient and
rational allocation of risks and rewards. Insider trading, stock manipulation,
monopolies, hoarding - all tend to consistently but unpredictably distort price
signals and, thus, deter market participation.
Market players take for granted the existence and continuous
operation of institutions - financial intermediaries, law enforcement agencies,
courts. It is important to note that market players prefer continuity and
certainty to evolution, however gradual and ultimately beneficial. A venal
bureaucrat is a known quantity and can be tackled effectively. A period of
transition to good and equitable governance can be more stifling than any level
of corruption and malfeasance. This is why economic activity drops sharply
whenever institutions are reformed.
II. Trust in other players
Market players assume that other players are (generally)
rational, that they have intentions, that they intend to maximize their benefits
and that they are likely to act on their intentions in a legal (or rule-based),
rational manner.
III. Trust in market liquidity
Market
players assume that other players possess or have access to the liquid means
they need in order to act on their intentions and obligations. They
know, from personal experience, that idle capital tends to dwindle and that the
only way to, perhaps, maintain or increase it is to transact with others,
directly or through intermediaries, such as banks.
IV. Trust in others' knowledge and ability
Market players assume that other players possess or have
access to the intellectual property, technology, and knowledge they need in
order to realize their intentions and obligations. This implicitly presupposes
that all other market players are physically, mentally, legally and financially
able and willing to act their parts as stipulated, for instance, in contracts
they sign.
The emotional dimensions of contracting are often neglected in
economics. Players assume that their counterparts maintain a realistic and
stable sense of self-worth based on intimate knowledge of their own strengths
and weaknesses. Market participants are presumed to harbor realistic
expectations, commensurate with their skills and accomplishments. Allowance is
made for exaggeration, disinformation, even outright deception - but these are
supposed to be marginal phenomena.
When trust breaks down - often the result of an external or
internal systemic shock - people react expectedly. The number of voluntary interactions
and transactions decreases sharply. With a collapsed investment horizon,
individuals and firms become corrupt in an effort to shortcut their way into
economic benefits, not knowing how long will the system survive. Criminal
activity increases.
People compensate with fantasies and grandiose delusions for
their growing sense of uncertainty, helplessness, and fears. This is a
self-reinforcing mechanism, a vicious cycle which results in under-confidence
and a fluctuating self esteem. They develop psychological defence mechanisms.Cognitive dissonance ("I really choose to be poor rather than
heartless"), pathological envy (seeks to deprive others and thus gain emotional
reward), rigidity ("I am like that, my family or ethnic group has been like that
for generations, there is nothing I can do"), passive-aggressive behavior
(obstructing the work flow, absenteeism, stealing from the employer, adhering
strictly to arcane regulations) - are all reactions to a breakdown in one or
more of the four aforementioned types of trust. Furthermore, people in a trust
crisis are unable to postpone gratification. They often become frustrated,
aggressive, and deceitful if denied. They resort to reckless behavior and
stopgap economic activities.
In economic environments with compromised and impaired trust,
loyalty decreases and mobility increases. People
switch jobs, renege on obligations, fail to repay debts, relocate often.
Concepts like exclusivity, the sanctity
of contracts, workplace loyalty, or a career path - all get
eroded. As a result, little is invested in the future, in the acquisition of skills, in long term
savings. Short-termism and bottom line mentality rule.The
outcomes of a crisis of trust are, usually,
catastrophic:
Economic activity is much reduced, human capital
is corroded and wasted, brain drain increases, illegal and extra-legal
activities rise, society is polarized between haves and haves-not, interethnic
and inter-racial tensions increase. To rebuild trust in such circumstances is a
daunting task. The loss of trust is contagious and, finally, it infects every
institution and profession in the land. It is the stuff revolutions are made of.
About the Author
Sam Vaknin is the author of "Malignant Self Love - Narcissism
Revisited" and "After the Rain - How the West Lost the
East". He is a columnist in "Central Europe Review", United
Press International (UPI) and ebookweb.org and the editor of mental health
and Central East Europe categories in The Open Directory, Suite101 and
searcheurope.com. Until recently, he served as the Economic Advisor to the
Government of Macedonia.
His web site: http://samvak.tripod.com
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Article Published/Sorted/Amended on Scopulus 2006-07-16 02:03:19 in Economic Articles
